What Is Car Financing?

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Car financing can seem a little overwhelming, especially if you are a first-time buyer, but once you understand the basics, you can proceed with confidence and strike a lucrative deal. After deciding the particular vehicle you wish to buy, you have some payment options to consider – pay for it in full or finance the car over time with a loan or a lease.

Financing the car with cash

As long as you keep sufficient savings to cover other major purchases or unexpected car costs in the future, paying cash is normally the cheapest way to buy your car. It means you own the car immediately. Moreover, while savings interest rates are low, it often makes sense to use savings rather than borrowing at a higher rate of interest. If you don’t have enough savings to buy the car outright, you could use what you can afford to put down the biggest deposit possible and then spend less on loan interest.

Financing the car with a loan

Most of us don’t have a large amount of cash required for a car, so the next option is an auto loan. Interest rates are definitely higher when you are financing a used car as opposed to a new one, so do shop around for the best rate. It is advisable to get a car loan with no prepayment penalty, as it saves money if you decide to pay off your loan early or refinance your car loan.

The factors you have to remember while considering a car loan are the following:

  • The loan amount – the total amount you borrow to get the car. This is necessary so you can calculate repayments that are made on a monthly basis, although you can ask your lender to allow weekly or fortnightly repayments if that suits your financial situation better. Making more frequent repayments can help to pay off the loan a lot sooner and with less interest.
  • Annual percentage rate, known as APR, which is the interest paid on the loan. It is calculated regularly on the outstanding balance. Before taking out a loan, you should always know what the interest rate is and compare rates being offered by a number of different lenders.
  • Loan term – the amount of time you have to pay back the loan amount. It generally lasts between 3 to 5 years. As mentioned, a shorter term means less interest, but a longer-term means smaller monthly installments.
  • Other fees and charges – There are several other fees you could be charged that can contribute significantly to the loan amount. These include an upfront/establishment fee, ongoing fees, the break fee, discharge fee, and late payment fee.
  • Balloon payment: A lot of car loan borrowers opt to have a balloon payment in the loan. A balloon payment is an agreed-upon lump sum that is paid to the lender at the end of the loan term. Borrowers who want smaller, regular repayments can opt for a balloon, but over the life of the loan, their total interest costs will be higher.

How do credit scores impact car finance?

Remember, just because you have a good credit score (calculated using reports from TransUnion, Equifax, and Experian) and you are allowed to borrow a larger amount, it doesn’t mean you can afford it. You need to work out the expenditures, take your monthly income into account in order to chalk out monthly payments as installments, and figure out if you can make all repayments for the full term of the deal. If you get behind on your car payments, talk to your finance company or lender as soon as possible. You might be able to return the car or pay off the loan early.

Financing a car with a lease

Most people think of auto financing as taking out a loan to buy a car, but leasing a car is another popular form of car financing. When you lease, you have to pay just a part of the vehicle’s cost, so basically you pay for using the car, and not for the vehicle itself. You might (or might not) have to shell out a down payment, while sales tax is charged on monthly payments in most states and you pay a financial rate called a money factor that is similar to the interest rate on a loan. There could be special lease-related fees and a security deposit

When you lease a car, you typically make lower monthly payments than if you were to buy the same car, but you aren’t gaining any equity in the vehicle (might become negative equity too) that could later translate to trade-in or resale value. You may have an option to buy the vehicle at the end of the lease period, but this will generally cost more than if you had purchased the vehicle to begin with. You have to keep tabs on how many miles you drive and take good care of the car or else damages will be charged.

Financing with ire purchase

To put it in a nutshell, you have to deposit around 10% of the car value and then make fixed monthly installments over a previously agreed upon period. Remember the car isn’t yours till the final payment, as compared to a personal loan (in this case you can lose the car if you miss payments). Hire purchase agreements are set up by the car dealer, and brokers also offer the service. This option is preferable for those buying new vehicles.

Once you have paid half the cost of the car, you might be able to return it and not have to make any more payments – check your contract to see if this applies to you. The lender can’t repossess your car without a court order, after you have paid a third of the total amount you owe.

Financing with Personal Contract Purchase (PCP)

A Personal Contract Purchase (PCP) is a tad more complex. It is like hire purchase that lets you use the car till the contract is over. Once it ends, you can return the car, pay resale value and keep it, or put the resale value towards buying a new car. Always factor in the creditworthiness assessment. First is the affordability of the PCP payments across the whole term of the contract based on your finances – think of it as finding out how difficult it is for you to keep up your repayments. The second is credit risk, which are the chances of you not paying your PCP loan back to the loan company. The deposit here is similar to hire purchase – 10%. Use the car and make your payments for the duration of the contract. Make sure you stay within your mileage restriction. There will be charges if you go over your limit.

Refinancing a car

It means replacing your current auto loan with a new loan from a different lender. This is done to work out more favorable repayment terms even when a loan is already in progress. The new loan comes with new features, benefits, and terms. For instance, you can choose the new loan and lower the overall interest rate. All you have to do is pay off your current loan and approach the new lender. Just ensure the prepayment penalty charged for your old auto loan is lower than the benefits offered by refinancing

When it comes to auto loan refinancing, you can use it to modify loan tenure as it helps to reduce monthly payments. If you extend your tenure through refinancing, you can repay your loan over a longer period of time with lower monthly payment plan But then again, it means a higher amount in total, which includes interest. On the contrary if you refinance to reduce loan term, it lets you clear off your loan quickly and decrease the interest amount that you pay.

Where can you get car financing from?

Car dealerships

This option is convenient and fast, but you have to be prepared for a big sales push on add-ons, while the loans are often front-loaded, which means payments are made up of more interest in the beginning of the loan than toward the end.

Banks/credit unions

You get competitive rates, personal service, no sales pitch for add-ons, and loans are usually simple interest loans. But working out the ins and outs can be a time-consuming process.

Online financial institution

This is an extremely quick and easy option that offers competitive rates, but if you aren’t careful, you could fall privy to frauds and scams since you are dealing with an unknown party.

Home equity loan

You get to deduct some of the interest from your taxes, while rates are competitive. But then again, you are combining your car and home as a single asset that could be a risky endeavor.

Have your heart and mindset on a particular car? Let DriveNation help you get the best deal with attractive financing offers so you can put your driving skills to the test as soon as possible! Reach us via phone or email anytime!

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About DriveNation

We are about always putting our customers’ needs first, DriveNation is committed to getting all of our customers approved for financing and driving a quality used car, used truck, or used SUV.

We have a team of auto finance specialists that will work hard to make sure you get the best interest rate your credit will allow. Our promise to you is that if you have questions about our services we will do our very best to make your experience with us as easy and as rewarding as possible. Expect full transparency, great customer service, and a vehicle you can count on.

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